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Automatic government spending cuts set to start in the US

US president Barack Obama faces another battle with his Republican rivals as he seeks a compromise over new spending cuts set to start tonight. $US 85 billion worth of government spending cuts are expected to wipe about half a per cent off economic growth this year. A Democrat plan to replace the reductions with new taxes failed to pass the Senate.

Transcript

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MARK COLVIN: It's called the sequester, and it's the biggest crisis to face the United States since the so-called fiscal cliff.

Barack Obama faces another battle with Republicans in Congress over new spending cuts set to start tonight.

Eighty-five billion US dollars worth of government spending cuts are expected to wipe out about half a per cent off economic growth this year.

A Democrat plan to replace the reductions failed to pass the Senate.

The president will meet Congressional leaders tonight to try and break the impasse.

Here's finance reporter, Sue Lannin.

SUE LANNIN: The North American economy is fragile. It barely grew in the last few months of 2012, weighed down by cuts to military spending and fewer companies restocking supplies.

Matt Sherwood is the head of investment strategy at Perpetual.

MATT SHERWOOD: Despite the fact that Wall Street continues to rise quite aggressively, what we do have is the weakest US recovery in history.

So at the moment, the US economy has expanded since the GFC trough at around 8 per cent in total over three and half years. So obviously the US economy is weak.

It's being held together by the continued fiscal stimulus and the low interest rates, and that is now starting to being unwind, so obviously that does mean that the outlook for the US economy still remains really subdued.

SUE LANNIN: President Barack Obama traded insults with his Republican rivals after a Democratic plan to raise $55 billion in new taxes was blocked by the Senate.

That means $85 billion worth of automatic spending cuts to bring down the budget deficit take effect today unless Mr Obama comes up with a last minute compromise.

Matt Sherwood thinks that's unlikely.

MATT SHERWOOD: Republicans are very driven to cut Government spending, so therefore just will not deal with the Obama administration.

And these spending cuts are going to go through, and they're certainly going to negatively impact growth.

SUE LANNIN: So what will that do to the US economy, spending cuts of that magnitude?

MATT SHERWOOD: It'll lead to a 2 per cent contraction in US GDP, and I think a spending cut and a tax increase of 2 per cent is likely to outweigh the positive contributions from rising housing construction, increased energy investment and the positive wealth effects from rising asset prices.

SUE LANNIN: Morgan Stanley senior executive James Dakin says the US needs to cut its huge public debt and $85 billion in spending cuts won't have a big impact on economic growth.

JAMES DAKIN: The fiscal cliff, there was a great fear it was going to lead the US into recession, and really it was a bit like Y2K and it wasn't - it was a bit of a fizzer in the end. This is even less so. So the potential cuts from the fiscal cliff were 3.5 per cent to GDP, which arguably would have put the US in recession if they'd all come through.

This year, we're talking about a half a per cent cut to US GDP. You're talking about $85 billion of spending cuts, when they have a trillion dollar deficit. I mean it's barely touching the surface.

The bigger issue is longer term how do they get their budget into balance?

SUE LANNIN: James Dakin says the looming fight over the US government's legal borrowing limit, the debt ceiling, is a bigger issue.

That will be the battle that new Treasury secretary, Jack Lew, will have to face. He's replaced Timothy Geithner, who stepped down last month.

Dr David Smith is a lecturer in American politics at the US Studies Centre at the University of Sydney.

DAVID SMITH: Jack Lew is a former budget director for both president Obama and president Clinton, and he was also president Obama's chief of staff.

Between the Clinton and Obama administrations he worked for Citigroup, in a unit actually, of Citigroup, that was enabled by the deregulation of Wall Street, especially by the repeal of the Glass-Steagall Act.

SUE LANNIN: So do you think he's a good choice?

DAVID SMITH: I don't think that he is a good choice, personally. I think that he represents a step back, and the reason is that when he was Clinton's budget secretary, he actually engineered a lot of the financial deregulation that certainly had an effect on the global financial crisis.

In particular, he was behind the Financial Services Modernisation Act and the Commodity Futures Modernisation Act, which allowed for the deregulation and trading of extremely complicated financial instruments such as derivatives, which even a lot of the people who were handling them really didn't understand how they worked.

This was a major cause of the global financial meltdown, and he does bear considerable responsibility for that.

MARK COLVIN: Dr David Smith from the US Studies Centre at the University of Sydney ending Sue Lannin's report.